Retirement

Eight ways to fix the U.S. retirement crisis

This update of a MarketWatch report that originally published on Sept. 9 clarifies the maximum dollar amount employees can contribute to a 401(k) plan.

BOSTON (MarketWatch) -- Paul Volcker and his troupe, the President's Economic Recovery Advisory Board, are unlikely to appear on the "America's Got Talent" stage any time soon. But retirement experts are giving the group, which just issued a 188-page plan to fix the nation's complicated retirement system, mostly high marks for their effort.

Volcker et al. recently laid out eight ways to simplify incentives aimed at encouraging U.S. workers to save for their retirement. Here's a look at those proposals and what experts had to say in reaction.

TAXES

Big tax bills can devastate your retirement
savings. MarketWatch's Robert Powell and Andrea Coombes talk about strategies to employ before and during retirement to lower your taxes.

"We believe these proposals will produce greater 'retirement readiness' for Americans within the existing framework of workplace-based retirement plans," said John "Jamie" Kalamarides, a senior vice president of retirement strategies and solutions at Prudential Retirement.

1. Consolidate retirement accounts; simplify rules

One reason saving for retirement is confusing is because there are so many different types of retirement accounts, including IRAs, 401(k)s, 403(b)s and SEP-IRAs. It can be hard to figure out whether you're eligible to contribute to a particular account and how much you can contribute.

A recent issue of Ed Slott's IRA Advisor detailed some of the confusion, noting the maximum dollar amount your employer can contribute to an employer-sponsored plan if you work for just one employer, in 2010: $49,000 for SEP-IRAs, profit-sharing plans and money-purchase plans. It's the same amount for 401(k)s and 403(b)s, counting employer and employee contributions combined. Unless you're age 50 or older, in which case it's $54,500. Keep in mind that the maximum worker contribution (not counting the employer's share) to a 401(k) or 403(b) is $16,500, plus another $5,500 for those aged 50 and older.

The contribution limits are different for SIMPLE IRAs ($23,000, plus $5,000 for those 50 and older) and 457 plans ($16,500, plus $5,000 for those 50 and older). And if you work for more than one employer, the contribution limits change.

"It makes a lot of sense to look for ways to consolidate different types of retirement-saving accounts, such as 401(k), 403(b), 457, and the like," said Peng Chen, chartered financial analyst and president of Ibbotson Associates, a Morningstar Company. "These plans by and large serve the same purposes, with slight differences among them."

Others, however, see it differently. "The American workplace is very diverse and the range of plan types reflects that diversity," said David Wray, president of the Profit Sharing/401(k) Council.

Wray said the proposed changes will have virtually no positive effect on retirement savings and, if not done right, could reduce the number of firms sponsoring plans, further putting in jeopardy the already precarious state of retirement security in the U.S.

"If the employer sponsors a plan, employees save," he said. "If not, employees don't save. Legislation to simplify the plan universe would have to be pursued carefully because a misstep could easily reduce plan sponsorship."

However, Wray was not unhappy with the proposal to make the contribution limits similar from plan to plan. "I do not have a problem with [that] as long as we continue to have the option for loans and hardship withdrawals," he said.

2. Integrate IRA and 401(k) contribution limits

One proposal would allow all workers irrespective of income to contribute to either or both an IRA and an employer-sponsored plan. In addition, Volcker's troupe proposed that nondeductible IRAs be eliminated since income limits on contributions would be removed.

Wray criticized this proposal, noting that "only a small percentage of lower paid workers not eligible for plan participation save in IRAs, and if they do the current IRA limits are sufficient for them."

3. Consolidate and segregate non-retirement savings

Volcker and the advisory board also called for consolidating all non-retirement savings programs, including Section 529 plans (whose rules are set by states and vary widely), Coverdell IRAs, health savings accounts, Archer medical savings accounts, and flexible savings accounts, under a single instrument. Contributions to this instrument could be tax-deductible up to a limit, as is currently the case for health savings accounts.

4. Improve savings incentives; expand auto-enrollment

The Volcker group also suggested designing the saver's credit to be more like a match, to increase its effectiveness as a savings incentive. This tax break provides a subsidy to low-income workers who make voluntary contributions to retirement plans.

At least one expert agreed that changes to the saver's credit would be beneficial. "Converting it to a match would make it more effective, both from the standpoint of encouraging more contributions and from the standpoint of getting the tax benefit into the individual's retirement account rather than his checking account," said Kaye A. Thomas, the founder of Fairmark Press Inc. "The cliffs in the current arrangement are brutally arbitrary, so a phase-out would be far better even if somewhat more complicated."

To Thomas, there's a right way to do this: Qualify people based on their previous year's income rather than their income for the year of the contribution, so that people know when they're contributing how much benefit they'll receive.

"To encourage participation, after people file their tax returns they would get a notice from the IRS saying that if you add X dollars to your retirement account in the coming year, we'll match it with Y dollars," Thomas said.

But Wray cited two problems with a saver's credit match. One, logistical reasons. "For example, those eligible for the credit are among our most mobile workers," Wray said. "The matches by definition will be made after the end of the tax year when as many as 20% of those eligible for the match will have changed employers. It will be a mess trying to match them with the right plan if they are even in a plan when the match arrives."

Two, it won't change behavior, he said. "Those eligible for the current credit and not saving in their plan are mostly trying to figure out how to afford to buy shoes for their children," he said.

"They are living totally in the moment and could not care less about an event decades away... This proposal would impose an expensive, logistically unworkable infrastructure on plans and result in little additional retirement savings," Wray said.

There were also mixed opinions on the idea of expanding automatic enrollment in workplace plans. "Proposals like these would reduce...behavior biases, thus potentially significantly increase savings over time," said Chen.

But though automatic enrollment is an excellent plan design, Wray said it works only when the plan sponsor is committed to the program. "It is not a panacea," Wray said. "In a typical plan, 70% of the employees save at a 7% rate. Where there is automatic enrollment the participation rate is likely to be 90% but the percent saved regresses to what is automatically deducted, typically 3%."

Put another way, 20% are better off but what about the other 70% who would have saved more on their own? Wray said his organization, the PSCA, is strongly opposed to mandating automatic enrollment.

Right now, employers can automatically enroll workers in a 401(k) plan and defer a certain percentage of their salary into qualified default investment accounts such as target-date funds.

5. Reduce retirement 'leakage'

The PERAB group proposes a rule requiring that, when a worker leaves a job, his account balance be retained in the existing plan, be automatically transferred to an IRA account, or get moved to an account with the new employer.

Volcker's "automatic rollover" would ensure that all amounts put aside for retirement continue to grow.

Wray had plenty to say against this proposal. "Pre-retirement access to funds is critical to get employees, especially younger, lower-paid employees, voluntarily to give up scarce dollars today for a benefit decades away," Wray said. "Locking down participant money until retirement in my opinion would greatly reduce retirement savings."

6. Simplify rules for employers sponsoring plans

One idea: simplify the so-called nondiscrimination test, for example by simplifying the definition of a high-paid employee and to provide a standard safe harbor to avoid these requirements.

An alternative proposal is to repeal nondiscrimination rules entirely and require all plans to meet a safe harbor standard. Right now, plenty of highly compensated employees can't contribute more than the maximum allowed to retirement accounts because of the nondiscrimination test.

Wray nixed this proposal as a non-starter. "Our system is a voluntary one," he said. "Employers need the flexibility to design plans that work for their workforce and their organization."

7. Simplify disbursements

Volcker's group called for eliminating minimum required distributions (MRD) -- which have among the most complicated rules on Earth -- for individuals with retirement assets below a threshold. Right now, most retirement account owners are required to take a distribution after turning 70-1/2 years old.

The proposed change would relieve many taxpayers from burdensome regulations at a relatively small cost. Experts in general praised the proposal -- though it may not go far enough.

"Excusing some from the MRD requirement is a positive step as this requirement ought to be totally repealed," Wray said. "The MRD requirement was imposed to increase the collection of federal taxes. It is bad public policy when people are living longer and longer."

Others agree with Wray. The proposal "makes sense both from the standpoint of simplicity and from the standpoint of helping people with inadequate retirement savings to preserve those savings," Thomas said.

8. Simplify taxation of Social Security benefits

The Volcker gang says simplifying the formula for calculating the tax on Social Security benefits would reduce the compliance burden on older taxpayers and improve economic efficiency.

Right now, trying to figure out Social Security benefit taxes is the near equivalent of those exercises designed to keep your brain fit in old age. "Making tax filing easier for seniors would be nice but this change would have little macro impact," said Wray.

Others had a different take. "The taxation of Social Security benefits is unnecessarily and almost absurdly complicated," Thomas said. "Simplification is long overdue."

Mortgage Rates

Powered by

This advertisement is provided by Bankrate, which compiles rate data from more than 4,800 financial institutions. Bankrate is paid by financial institutions whenever users click on display advertisements or on rate table listings enhanced with features like logos, navigation links, and toll free numbers. Dow Jones receives a share of these revenues when users click on a paid placement.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.